Housing reform sinks to Fannie/Freddie mash-up low

By Agnes T. CraneThe author is a Reuters Breakingviews columnist. The opinions expressed are her own.

For the clearest sign yet that U.S. housing reform is floundering, just take a look at the latest proposal. Two lawmakers, with industry lobbyists in tow, are heralding a union of Fannie Mae and Freddie Mac, which would leave the government still in charge. Even more than other ideas floating around, it would preserve the status quo. It only goes to show just how weak the political will is for a real fix.

The full details are still forthcoming but early reports hardly inspire much confidence. The newly created Frannie, as it were, would look a lot like the old government-sponsored entity framework. It would buy mortgages, package them into tradable bonds and, most significantly, come with a government guarantee. After pumping more than $160 billion into Fannie and Freddie, Uncle Sam should be seriously questioning guarantees, not embracing them.

Since being seized by the government three years ago, Fannie and Freddie have become even more important to U.S. housing. By propping up the market, this has terrified the real estate industry and consumer groups into thinking the disappearance of the GSEs would herald yet another downturn in home prices. That fear isn’t without merit. Fannie and Freddie, together with the Federal Housing Administration, are guaranteeing roughly nine out of 10 new mortgages and back roughly half the $10.6 trillion market.

But the debate needs to be far less myopic. Wringing out excesses, for one, will mean demand for home loans won’t return to the go-go days of yesteryear. That means the private sector could eventually shoulder a bigger share. Proposals should pave the wave for transferring risk back to where it belongs — the homeowner, the lender and other investors. Uncle Sam has already done more than his fair share.

The duration of the debate over Fannie and Freddie makes the path of least resistance — especially for politicians worried about re-election and other front-burner issuers like the deficit — ever more appealing. The proposal, from Representatives Gary Miller of California and Carolyn McCarthy of New York, crystallizes just what can happen when a crisis fades from view and indecision persists for too long. Few expect Congress to enact any legislation on U.S. housing reform until at least 2013 anyway. Sadly, that should make selling the status quo even easier.

Truly disappointing, if that’s the direction this is going in. The gross failure of the GSE’s was in loosening their underwriting criteria (ostensibly to increase US home ownership): verification of income, limits to loan-to-value, and appraisals that made sense. The old rule of thumb was you could afford a home price up to 4 times your annual income. In various markets the ratio was up to 15 times income in 2006-7. The loan originators need the liquidity the GSE’s provide; but have a put back to the originator in case of a default, so the originator still has some “skin in the game”.

The “gross failure” was having these GSE’s in the first place. Even though it was set up in the first place to act somewhat like a private enterprise in that they said that their loans were not guaranteed by the government, etc, the government ended up playing that guarantor role anyway, as people no doubt guessed that they would.

No private entity would ever have made the purchases that the GSE’s did–it would have been obvious that they were taking risk they couldn’t back up and no one would have wanted to buy their derived securities.

(People often focus on sub-prime lending, but the real oxygen/fuel combination was cheap credit due to the Fed’s (multi-administration) policies plus a GSE that would buy mortgages from you and take away your risk. Artificially cheap liquidity will always look for a way to be spent. The idea of having some entity out there that would buy your 300,000 dollar loan from you, practically-no-questions-asked, plus an extremely low interest rate for the person you’re loaning the money to, is a recipe for exactly what happened–gigantic bubble.

People were just doing everything they could to get in on the insane market that followed as a result of these incredibly short sighted government actions. Eventually there was no one left to sell to so they tried to expand the market to people who really, really should never have had that kind of money lent to them, giving you sub-prime lending, but that was at the end of a huge, huge amount of malinvestment. Blaming sub-prime for the crisis is like blaming the last straw for breaking the camel’s back, but people still do it.)